American Idle

The U.S. has 3,779 power plants that use petroleum as fuel, and 1,396 plants that use coal. Yet last year, only 0.56% of the nation's electricity came from petroleum and 44.8% came from coal. What is going on?

It turns out that the nation's coal plants are larger than their oil-based cousins, and they are busy producing electricity. Oil-fired plants are idle most of the time because their production costs are much higher. The driver is fuel. Coal costs about $2.50 per million British thermal units (BTUs) and fuel oil costs more than $20 by comparative measures.

Those numbers are about to change. The Environmental Protection Agency recently issued rules that will require the nation's coal plants to clean up their emissions. Regulations cost money, and many utilities would rather retire old and inefficient coal plants than invest in pollution control technologies. Utilities making these decisions are not taking political positions; they are simply looking at the numbers and making sound business decisions.

The EPA expects the regulations to result in approximately 10,000 megawatts worth of coal plants being retired. The industry expects approximately 60,000 megawatts to retire, or six times more than the EPA's estimate. Retiring 60,000 megawatts is the equivalent of removing 50 to 60 nuclear power plants from the nation's roster.

It just so happens that 60,000 megawatts is also the equivalent of all the nation's oil-fired power plants. With so much coal capacity exiting, deregulated energy markets may be forced to rely on oil more than anyone ever expected.

There are no incentives for power producers to build new capacity in deregulated power markets. While the energy markets are efficient, the capacity markets are not. Even if producers wanted to build new units, their investors would demand a hedge that no longer exists in restructured markets. Lacking that hedge, producers are unable to secure financing.

Without new capacity coming online, regional grids will normally experience a net reduction of capacity. With new EPA regulations, that reduction will accelerate. Grids will be forced to rely on what remains: Inefficient natural gas and oil-fired power plants.

The problem is heightened in states and areas with more oil-fired capacity: Florida, New York, Pennsylvania, Massachusetts, Maryland, Connecticut, Virginia, Georgia, Hawaii, Missouri, New Jersey, Illinois, Ohio, Indiana, Louisiana, Maine, Minnesota, Wisconsin, South Carolina, and the District of Columbia. All have the equivalent of at least one nuclear power plant worth of oil-fired capacity, and most have more. Florida, for example, has the equivalent of 13 nuclear power plants. New York has the equivalent of six nuclear plants.

Most oil-fired capacity is located near the four eastern power markets: PJM Interconnection, Midwest ISO, New York ISO and ISO New England. Since power tends to flow between grids and towards the New York-Washington corridor, even distant deficiencies can have local consequences.

For eastern population centers, the consequences could be significant. Surprisingly, most of the exiting 60,000 megawatts of coal capacity is located in the same region, with significant oil-fired capacity. Consequently, regional power markets will be short capacity. Higher electricity prices and load dumping will follow.

Simple arithmetic explains why. If fuel oil worth 138,690 BTUs is priced at $3 per gallon, and a power plant has an efficiency rating of 10,000 BTUs per kilowatt-hour, then it will cost producers $216.30 to produce one megawatt-hour in a market that normally trades below $50. Either the market price for energy must reach $216.30 or the system will find ways to reduce demand.

Remember, the most expensive plant in the merit order sets the market-clearing price. If one oil-fired power plant is dispatched, the locational price of wholesale power will be more than $216.30 for all generators. If a company owns nuclear or coal plants in that market, their margins will be spectacular -- unless demand-side management programs are aggressively marketed.

A number of companies could win if 60,000 megawatts of coal plants exit the market. NRG Energy (NRG) owns several oil-fired power plants in the same markets. They also own coal-fired plants nearby. The combination sets them up to become potential winners.

It's not just NRG. GenOn Energy (GEN), Exelon (EXC) and Public Service Enterprise Group (PEG) also earn significant revenue from the same markets. Exelon operates 10 generating power plants and 17 reactors. When it acquires Constellation Energy Group (CEG), its position in this market will be strengthened.

Changing federal regulations has consequences, and some companies clearly benefit from the EPA's new rules.